Question #28
Reading: Reading 21 Free Cash Flow Valuation
PDF File: Reading 21 Free Cash Flow Valuation.pdf
Page: 12
Status: Correct
Correct Answer: A
Question
The two-stage (stable growth) free cash flow to equity (FCFE) and free cash flow to the firm (FCFF) models typically assume:
Answer Choices:
A. a high level of free cash flow for n years and then a lower level of free cash flow thereafter
B. high growth in free cash flow for n years and then constant growth in free cash flow forever after
C. growth of free cash flow that declines to the required rate of return in the last stage
Explanation
The two-stage model using either FCFE or FCFF typically assumes a high growth of free
cash flow for n years and then a constant growth in free cash flow forever after. Multi-
stage models assume that the required rate of return exceeds the growth rate in the last
stage. In a two-stage free cash flow models, the growth rate in the second stage
represents the long-run sustainable growth rate, which is generally a low rate that is close
to the GDP growth rate.